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1) The payoffs for financial derivatives are linked to

previously issued securities.

2) Financial derivatives include

futures.

3) Financial derivatives include

forward contracts.

4) Which of the following is not a financial derivative?

Stock

5) By hedging a portfolio, a bank manager

reduces interest rate risk.

6) Which of the following is a reason to hedge a portfolio?

To limit exposure to risk.

7) Hedging risk for a long position is accomplished by

taking a short position.

8) Hedging risk for a short position is accomplished by

taking a long position.

9) A contract that requires the investor to buy securities on a future date is called a

long contract.

10) A long contract requires that the investor

buy securities in the future.

11) A person who agrees to buy an asset at a future date has gone

long.

12) A short contract requires that the investor

sell securities in the future.

13) A contract that requires the investor to sell securities on a future date is called a

short contract.

14) If a bank manager chooses to hedge his portfolio of treasury securities by selling futures contracts, he

gives up the opportunity for gains.

removes the chance of loss.

To say that the forward market lacks liquidity means that

it may be difficult to make the transaction.

16) A disadvantage of a forward contract is that

it may be difficult to locate a counterparty.

the forward market suffers from lack of liquidity.

these contracts have default risk.

17) Forward contracts are risky because they

are subject to lack of liquidity

are subject to default risk.

18) The advantage of forward contracts over future contracts is that they

(a) are standardized.

(b) have lower default risk.

(c) are more liquid.

(d) none of the above.

Answer: D

Forward contracts are of limited usefulness to financial institutions because

of default risk.

of lack of liquidity.

21) Futures contracts are regularly traded on the

Chicago Board of Trade.

22) Hedging in the futures market

eliminates the opportunity for gains.

eliminates the opportunity for losses.

23) When interest rates fall, a bank that perfectly hedges its portfolio of Treasury securities in the futures market

has no change in its income.

Parties who have bought a futures contract and thereby agreed to _____ (take delivery of) the bonds are said to have taken a ____ position.

buy; long

26) Parties who have sold a futures contract and thereby agreed to _____ (deliver) the bonds are said to have taken a ____ position.

sell; short

27) By selling short a futures contract of 100,000 at a price of 115 you are agreeing to deliver

100,000 face value securities for 115,000.

28) By selling short a futures contract of 100,000 at a price of 96 you are agreeing to deliver

100,000 face value securities for 96,000.

On the expiration date of a futures contract, the price of the contract

always equals the price of the underlying asset.

31) The price of a futures contract at the expiration date of the contract

equals the price of the underlying asset.

32) Elimination of riskless profit opportunities in the futures market is

arbitrage.

33) If you purchase a 100,000 interest-rate futures contract for 110, and the price of the Treasury securities on the expiration date is 106

your loss is 4000.

34) If you purchase a 100,000 interest-rate futures contract for 105, and the price of the Treasury securities on the expiration date is 108

your profit is 3000.

If you sell a 100,000 interest-rate futures contract for 105, and the price of the Treasury securities on the expiration date is 108

your loss is 3000.

37) If you sold a short contract on financial futures you hope interest rates

rise.

38) If you sold a short future contract you will hope that interest rates

rise.

39) If you bought a long contract on financial futures you hope that interest rates

fall.

If you bought a long future contract you hope that bond prices

rise.

41) If you sold a short future contract you will hope that bond prices

fall.

42) To hedge the interest rate risk on 4 million of Treasury bonds with 100,000 futures contracts, you would need to purchase

40 contracts.

43) If you sell twenty-five 100,000 futures contracts to hedge holdings of a Treasury security, the value of the Treasury securities you are holding is

2,500,000.

When a financial institution hedges the interest-rate risk for a specific asset, the hedge is called a

micro hedge.

44) Assume you are holding Treasury securities and have sold futures to hedge against interest rate risk. If interest rates rise

the decrease in the value of the securities equals the increase in the value of the futures contracts.

Assume you are holding Treasury securities and have sold futures to hedge against interest rate risk. If interest rates fall

the increase in the value of the securities equals the decrease in the value of the futures contracts.

46) When a financial institution hedges the interest-rate risk for a specific asset, the hedge is called a

micro hedge.

47) When the financial institution is hedging interest-rate risk on its overall portfolio, then the hedge is a

macro hedge.

48) The number of futures contracts outstanding is called

open interest.

49) Which of the following features of futures contracts were not designed to increase liquidity?

Marked to market daily

Which of the following features of futures contracts were not designed to increase liquidity?

Can be closed with off setting trade

51) Futures differ from forwards because they are

a standardized contract.

52) Futures differ from forwards because they are

marked to market daily.

53) The advantage of futures contracts relative to forward contracts is that futures contracts are standardized, making it easier to match parties, thereby increasing liquidity.

specify that more than one bond is eligible for delivery, making it harder for someone to corner the market and squeeze traders.

54) If a firm is due to be paid in deutsche marks in two months, to hedge against exchange rate risk the firm should

sell foreign exchange futures short.

If a firm must pay for goods it has ordered with foreign currency, it can hedge its foreign exchange rate risk by

buying foreign exchange futures long.

56) If a firm is due to be paid in deutsche marks in two months, to hedge against exchange rate risk

the firm should _____ foreign exchange futures _____.

sell; short

57) If a firm must pay for goods it has ordered with foreign currency, it can hedge its foreign exchange rate risk by _____ foreign exchange futures _____.

buying; long

58) Options are contracts that give the purchasers the

option to buy or sell an underlying asset.

59) The price specified on an option that the holder can buy or sell the underlying asset is called the

strike price.

The price specified on an option that the holder can buy or sell the underlying asset is called the

strike price.

exercise price.

61) The seller of an option has the

the obligation to buy or sell the underlying asset.

62) The seller of an option is ______ to buy or sell the underlying asset while the purchaser of an option has the ______ to buy or sell the asset.

obligated; right

63) The amount paid for an option is the

premium.

64) An option that can be exercised at any time up to maturity is called a(n)

American option.

An option that can only be exercised at maturity is called a(n)

European option.

66) Options on individual stocks are referred to as

stock options.

67) Options on futures contracts are referred to as

futures options.

68) An option that gives the owner the right to buy a financial instrument at the exercise price within a specified period of time is a

call option.

69) A call option gives the owner

the right to buy the underlying security.

A call option gives the seller

the obligation to sell the underlying security.

71) An option allowing the holder to buy an asset in the future is a

call option.

72) An option that gives the owner the right to sell a financial instrument at the exercise price within a specified period of time is a

put option.

73) A put option gives the owner

the right to sell the underlying security.

74) A put option gives the seller

the obligation to buy the underlying security.

75) An option allowing the owner to sell an asset at a future date is a

put option.

76) If you buy a call option on treasury futures at 115, and at expiration the market price is 110,

the call will not be exercised.

77) If you buy a call option on treasury futures at 110, and at expiration the market price is 115,

the call will be exercised.

78) If you buy a put option on treasury futures at 115, and at expiration the market price is 110,

the put will be exercised.

79) If you buy a put option on treasury futures at 110, and at expiration the market price is 115,

the put will not be exercised.

80) If, for a 1000 premium, you buy a 100,000-call option on bond futures with a strike price of 110, and at the expiration date the price is 114

your profit is 3000.

81) If, for a 1000 premium, you buy a 100,000-call option on bond futures with a strike price of 114, and at the expiration date the price is 110

your loss is 1000.

82) If, for a 1000 premium, you buy a 100,000 put option on bond futures with a strike price of 110, and at the expiration date the price is 114

your loss is 1000.

83) If, for a 1000 premium, you buy a 100,000 put option on bond futures with a strike price of 114, and at the expiration date the price is 110

your profit is 3000.

84)The main advantage of using options on futures contracts rather than the futures contracts themselves is that

interest rate risk is controlled while preserving the possibility of gains.

85) The main reason to buy an option on a futures contract rather than the futures contract is

to preserve the possibility for gains.

86) The main disadvantage of hedging with futures contracts as compared to options on futures contracts is that futures

remove the possibility of gains.

87) If a bank manager wants to protect the bank against losses that would be incurred on its portfolio of treasury securities should interest rates rise, he could

buy put options on financial futures.

88) Hedging by buying an option

limits losses.

89) All other things held constant, premiums on options will increase when the

term to maturity increases.

90) All other things held constant, premiums on call options will increase when the

exercise price falls.

91) An increase in the exercise price, all other things held constant, will ______ the call option premium.

decrease

92) All other things held constant, premiums on options will increase when the

volatility of the underlying asset increases.

93) An increase in the volatility of the underlying asset, all other things held constant, will ______ the option premium.

increase

94) A tool for managing interest rate risk that requires exchange of payment streams is a

swap

95) A financial contract that obligates one party to exchange a set of payments it owns for another set of payments owned by another party is called a

swap.

96) A swap that involves the exchange of a set of payments in one currency for a set of payments in another currency is a(n)

currency swap.

97) A swap that involves the exchange of one set of interest payments for another set of interest payments is called a(n)

interest rate swap.

98) A firm that sells goods to foreign countries on a regular basis can avoid exchange rate risk by

selling a foreign exchange swap.

99) The most common type of interest rate swap is

the plain vanilla swap.

100) If Second National Bank has more rate-sensitive assets than rate-sensitive liabilities, it can reduce interest rate risk with a swap that requires Second National to

receive fixed rate while paying floating rate.

101) If a bank has more rate-sensitive assets than rate-sensitive liabilities

it reduces interest rate risk by swapping rate-sensitive income for fixed rate income.

102) If Second National Bank has more rate-sensitive liabilities then rate-sensitive assets, it can reduce interest rate risk with a swap that requires Second National to

pay fixed rate while receiving floating rate.

103) One advantage of using swaps to eliminate interest rate risk is that swaps

are less costly than rearranging balance sheets.

104) A advantage of using swaps to hedge interest rate risk is that swaps

can be written for long horizons.

105) The disadvantage of swaps is that they

lack liquidity.

are difficult to arrange for a counterparty.

suffer from default risk.

106) A disadvantage of using swaps to control interest rate risk is that

swaps, like forward contracts, lack liquidity.

107) The problems of default risk and finding counterparties for interest rate swaps has been reduced by

commercial and investment banks serving as intermediaries.